There is a simple misconception about how the process of lending works. This article will try and summarize some of the basics of the lending process. We'll start with the very basic question about getting loans in the name of a business entity, then discuss some of the fine points of lending.
Many investors consider asset protection a very important part of their beginning strategy. So, the first questions that many investors asks, is "How do I get a loan in the name of my company?" The answer to this question depends on things like credit and available assets...personal assets, namely cash or other liquid assets.
Many "rehab lenders" who specialize in lending money to real estate rehab investors will lend to a new business entity with a personal guarantee by the borrower who signs for the loan. Why do lenders require this? Certain business entities offer limited liability for business debts.
Have you ever purchased any stock in a company? Let's say you purchased 10 shares of Microsoft, how would you like it if you were personally held liable for the debts of Microsoft for the amount of your investment? You, as a shareholder of Microsoft, are not personally liable for the debt or the legal cases brought against it. So getting back to the original point, a lender is not about to fork over $150,000 and not have either a business with assets or an individual liable for the repayment of the debt.
Even though a mortgage is an asset for the bank, it is only an asset as long as that note is performing (being paid off by the borrower). Lenders want the ability to know that the money loaned will be repaid or that they will have the ability to seize assets of the borrower.
The next question many new investors ask is, "Can I transfer ownership from me personally to my business entity?" The smart answer is no. First of all, what purpose would this serve? The business does not receive credit for paying down the debt. Secondly, a quitclaim deed is considered a violation of a due on sale clause which is written into most (if not all) mortgage agreements and even though the not continues to be paid and in good standing, a lender will not take lightly to finding out a transaction like this has taken place, leaving them out of the loop. Lenders like to be in control of their assets. Many people will say that lenders just won't find out due to the nature and size of their business, but make no mistake, as a borrower, you've signed a contract with an entity that has loaned you a significant amount of money. They're not just going to ignore the fact that a borrower has violated the contract.
The consequences for conducting your investments in this manner do not mean you will go to jail. There is no jailhouse for violators of due-on-sale-clauses. The consequences though may very well be the loan being called due with no exceptions. This may cause the investment to be foreclosed on and great damage to your personal credit to result.
When other lenders realize this, they may start to sniff around and before you know it, all your loans are being called due, leaving you with little or no recourse. Personally guaranteeing a loan is definitely a way to accomplish obtaining a loan for your business entity to purchase things like real estate. By doing so however, you are putting your personal assets and credit on the line. This decision can only be made by the individual investor.
In order to obtain a loan for purchasing real estate, in most cases, the bank will be looking at the property itself and the borrower. For beginning investors especially, banks will require every detail of the property and borrower. To explain briefly the difference between a purchase and a refinance loan, it is important for investors to realize the big difference between these two types of financing.
A loan for a purchase of real estate is based in almost every circumstance on the agreed upon purchase price of the property. Bank certified appraisals will almost definitely match the purchase price. It does not matter if the investor is buying the property 50% below market. The bottom line to a bank is the price being paid.
Conversely, refinance loans are based on the true value of the property. Quite a few banks will provide a very high Loan To Value (LTV) on refinance loans. The difference is the owner already has rights to the property. A certain history is there that indicates the owner is paying the current loan (or paid it off).
Additionally, the equity in the property, if great enough, will be encouraging to the bank based on the value of the property. The difference is the risk the bank has to take. A buyer, technically, has no history of performance on a loan when it comes to buying a property. Thus, the risk must be evaluated and measured. An owner in most cases, even if it's only one year, has a history of actually paying his/her debts.
This works the same exact way for a business. "Credit history" means something to a bank. When they look at businesses to lend money to, they measure the assets, liabilities, and equity of the company, plus the type of responsibility the owners/managers take in paying back debts and bills. They just don't blindly loan money to anyone, without having a good idea of how their money will be paid back.
So as you consider buzz phrases like "asset protection" and "business entity", you must realize that there are certain paths you can take toward financing your business/investments. The possibilities and ideas you discover may not be as easy as you once thought. However, like anything else, once you start actually doing it, it becomes like a bicycle ride. Just don't ever forget to look both ways...twice, before crossing any path.
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